The amount of savings one can make over a longer period of time more than compensates for the extra work that one needs to put in making the right selection in terms of mutual funds.
If you are new to mutual funds or don’t have the time to dig deep, it is quite natural that you would be utterly confused while choosing the right mutual fund plan that matches your financial goals. The market is flooded with numerous mutual fund plans which have a diverse range of categories and sub-categories that cater to different asset classes, investment styles, themes, risk profile, etc. This makes it especially tough to zero in on the right plan. The role of a financial advisor who sometimes also is a mutual fund distributor is to help his/her clients make the right financial decision. Of course this advice is not for free. The fee of a financial advisor comes from mutual fund asset management companies (AMC) in the form of upfront and trail commission. Asset management companies pass on these costs to their customers in the form of expenses that reduce the net asset value (NAV) of the underlying plan. That is the primary reason that buying a mutual fund directly from the AMC is cheaper then opting for a direct plan through a financial advisor/mutual fund distributor.
These distributors get a commission from the mutual fund companies for every investment that is charged to the funds as expense ratio. There are some problems that need to be highlighted in the distributor based regular plans. The financial advisor/MF distributor gets a commission for every year the investment stays with the AMC, which basically means that after the initial financial advice the financial advisor gets paid without making much effort. Conflict of interest is another concern that is often problematic from an investor’s point of view. Different AMCs offer different commission rates. Therefore, financial advisors are often biased towards AMCs that provide better commissions and because of that the investor is sometimes short changed as he/she is not getting an unbiased financial advice.
Technological advancement in the form of online purchase and sale of mutual funds and increased financial awareness has enabled investors to make their own investment decisions. Acknowledging such investor class, in 2013 the Securities and Exchange Board of India (SEBI) directed the mutual fund houses to offer their products both in the form of a direct plan as well as a regular plan. Investors can buy these direct plans directly from the fund houses without the involvement of financial intermediaries or the expenses associated with them. As of today, every mutual fund offers regular plans as well as direct plans. The scheme characteristics such as their fund management, investment objectives, asset allocation strategy, investment style and portfolio composition are the same for both the categories of mutual funds. An investor is also allowed to choose between lump sum, SIP and STP modes of investment as well as between growth and dividend options that are standard to the regular plans. The only difference between the two categories of mutual funds is in their NAVs and expense ratios.
Expense ratio is the percentage of a fund’s average daily net assets used for meeting its annual operating expenses and includes expenses such as fund management, administration, advertising expenses etc., in addition to the commissions paid to the intermediaries. In other words, expense ratio is the fee the mutual funds take from you for managing your investments. This is usually between 0.5% and 2.5% of the total amount invested. As mutual fund houses do not incur distribution expenses in direct plans, such plans have lower operating expenses than regular plans. The lower expense ratio of direct plans translates into higher returns for investors. Generally, the expense ratios of direct plans are 0.5 to 1.5 percentage point lower than their regular counterparts. As direct plans have lower expense ratios, they deduct lower amounts from their net AUM. This leads them to register higher NAV. As time progresses, the gap between their NAVs becomes larger.
The following tables depict how the return & expense ratio differ between select direct and regular mutual fund plans:
Note: NAV & Returns data as on: 26-April-19, Data Source: Value Research
Note: Data as on: 26-Apr-19; Data Source: Value Research
There are several distinct advantages of opting for a direct mutual fund plan:
# Higher Returns – Direct plans always generate higher returns in comparison to regular plans as these plans do not have to incur distribution expenses, the same savings are invested back in the fund. Consequently the investor is able to get higher returns. Although the difference might seem insignificant in the initial years, the power of compounding makes it substantial over the long term. Many people often do not realize the long-term financial implications of opting for a direct plan instead of a regular plan. For example, as a part of your retirement plan, you start a monthly SIP of Rs 10,000 through the direct plan of a mutual fund scheme at the age of 25 and continue with the SIP for 35 years, the plan would create a corpus of Rs 11.28 crore at the time of retirement assuming an annualized return of 15%. If the annualized return from a regular plan were 1% lower return than the direct counterpart, the same SIP would have grown to Rs 8.84 crore which amounts to a difference of Rs 2.44 crore over a period of 35 years.
# Simplified Process – It’s not too hard to opt for direct plans as you can directly buy these plans from the mutual fund houses, either online or through their branch offices. Even for situations where an investor decides to buy direct plans through several AMCs, the process can be streamlined if he/she opts to buy these plans from an online mutual fund market place absolutely free.
# Knowledge Bank and hand holding – With advancement in technology and the emergence of online financial market places. it has become very convenient for even first-time investors to buy or sell mutual funds directly. These online market places have a plethora of data and information that helps an investors in making the right financial decisions. The advanced search engines on these platforms are able to offer customized mutual fund baskets that suit one’s financial plan, and the best part is all of this is absolutely free. First-time investors can avail these services on these platforms. In addition to enabling the sale and purchase of mutual funds, these platforms also provide market insights, fund recommendations, online tools and calculators that help investors in making the right investment decisions as per their financial goals, risk appetite and investment horizon
To conclude, the choice between a direct plan and a regular plan is simpler than one thinks. The amount of savings one can make over a longer period of time more than compensates for the extra work that one needs to put in making the right selection in terms of mutual funds. If one has the willingness to take control of one’s financial decisions and the determination to learn and go through the process on their own, opting for a direct mutual fund plan should be the default choice. For investors who do not have the luxury of time and who are not comfortable in making an informed financial decision based on personal research, it is advisable to opt for regular mutual funds with the help of a financial advisor.
(By Rahul Agarwal, Director, Wealth Discovery/EZ Wealth)